Proof that the property market is driving inequality

With his bestselling book Capital in the 21st Century, the leftwing French economist Thomas Piketty has presented the right with a serious intellectual challenge – not least, in deciding how to pronounce ‘Piketty’.

Of course, Piketty’s work faces numerous counter-challenges – and according to the Economist, the “most serious and substantive critique” comes from an economics PhD student called Matthew Rognlie (I don’t know how to pronounce that one either).

The core of Piketty’s argument is the now infamous formula r > g, where ‘r’ is the rate of return on capital and ‘g’ is the growth rate of the whole economy. If the former remains greater than the latter in the long-run, then the rich (i.e. those with capital) will accumulate an ever larger proportion of the nation’s wealth, leaving an ever smaller proportion for everyone else. Therefore, in the absence of capital-destroying events like war and natural disaster, the only way of stopping the slide towards total inequality is a confiscatory tax on wealth (which would have to be global to prevent capital flight).

Rognlie undoes the underpinnings of Piketty’s grand theory in a number of ways. For instance, he believes that it is wrong to assume that the rate of return on capital stays high in the long-term:

“Modern forms of capital, such as software, depreciate faster in value than equipment did in the past: a giant metal press might have a working life of decades while a new piece of database-management software will be obsolete in a few years at most. This means that although gross returns from wealth may well be rising, they may not necessarily be growing in net terms, since a large share of the gains that flow to owners of capital must be reinvested.”

He also examines the claim that income from capital is taking a growing share of national income (leaving a diminishing share for wages). This has been much argued over by others, but what Rognlie does is look at different kinds of capital-derived income. What he found is of crucial importance:

“The return on non-housing wealth, in fact, has been remarkably stable since 1970… Instead, surging house prices are almost entirely responsible for growing returns on capital.”

In other words, it is the property market that is driving the growth in wealth inequality. Proper capitalism – i.e. the capitalism concerned with productive endeavour as opposed to land-based Ponzi schemes – is not to blame.

Rognlie’s findings are based on average figures for all the G7 economies. However, it wouldn’t be unreasonable to assume that inequality has been driven particularly hard in those countries with the most over-heated property markets – the UK, for instance.

It would also be interesting to see who was benefitting most from this phenomenon. When we speak of homeowners we’re not just talking about owner-occupiers, but landlords and other owners of ‘investment properties’. It’s also worth remembering that non-residential land, especially farmland, has appreciated at an even faster rate than land with houses on it. This, too, is a target for investors.

Bear this in mind as you consider the conclusion to the Economist article:

“Mr Piketty used the historical evidence in his book to argue that a global tax of up to 2% a year on individual wealth should be introduced in order to prevent capital concentrating in the hands of the few. But if housing wealth is the biggest source of rising wealth then a more focused approach is called for. Policy-makers should deal with the planning regulations and NIMBYism that inhibit housebuilding and which allow homeowners to capture super-normal returns on their investments.”

This is right in respect to the misconceived Piketty tax, but wrong in imagining that simply building more houses is an adequate alternative response. In fact, the evidence suggests that crude building booms only succeed in sucking in more capital looking for an easy return.

The real solution is to build the homes we need, but to use taxation and other measures to push rentier money out of the property market and into real businesses instead.